Ros Altmann is a former Pensions Minister who now sits in the House of Lords.
Recent weeks have seen an almost non-stop flow of suggested pension policy reforms for the upcoming Budget.
Because so much public money is spent on pensions, and many commentators believe money should be redistributed away from the old to the young, several radical ideas have been proposed.
The Chancellor Rachel Reeves should aim to change as little as possible in the near-term and avoid adding new complexities, while ideally encouraging more pension contributions to benefit British growth and investment.
Pensions could help revive the British economy, but damaging policy changes could also undermine the whole concept of pension saving and destroy confidence for the future, leaving millions poorer in later life.
Let’s run through what the Chancellor might introduce in the Budget on 26 November, plus a couple of pension reforms which I consider beneficial and would get my support.
Here’s how the Chancellor COULD overhaul pensions in the Budget
1. Cut tax-free cash
There have been strong rumours that the Chancellor would like to reduce the amount of tax-free cash that people can take from their pensions. Currently, up to a quarter of most pension funds can be withdrawn tax-free and spent as you like.
Unless you have a protected sum, the maximum amount of tax-free withdrawals is capped at £268,275. This could be reduced to, say, £50,000.
Ros Altmann: Pensions could help revive the British economy – but damaging policy changes could undermine them
This change would particularly hit people relying on using their tax free lump sum to pay off a mortgage or other loans, who would now face a high tax bill to withdraw the money.
The rumours of this possible change have already caused huge amounts of money to be withdrawn from pensions, just in case the limit is lowered.
Many of those taking money out now may regret this later if there is no change, while those not quite at age 55 (the minimum age that you can make such withdrawals) will be most upset if the change does happen.
The pros of reducing tax-free cash would be significant extra revenue for the Chancellor, without hitting those with more modest pensions, so from a social equity perspective the Government may find this tempting.
The cons of such a draconian retrospective change include severely damaging confidence in pension saving and undermining the attraction of pensions overall.
2. Impose National Insurance on pensions in payment
Another change that has been rumoured is for the Chancellor to start charging National Insurance on the income older people take from their pensions.
Currently, pensioners’ income is subject only to income tax, and a quarter is tax-free.
The Chancellor could introduce a new National Insurance pension levy, which could be at much lower levels than the full rate of 8 per cent that applies to anyone earning more than around £12,500 a year.
It could perhaps be set at the 2 per cent rate which applies to working age people earning over around £50,270 a year.
Average pensioner incomes in the UK are approximately £21,000 a year. Assuming say, eight million pensioners pay 2 per cent on £9,000 of income (the amount above the personal allowance) they would each pay around £180 a year in new tax and the Chancellor would receive about £1.4billion in extra revenue.
The pros would be the Chancellor receives significant extra revenue, and higher taxes on pensioners would ‘level the playing field’ with working people.
It could be portrayed as an issue of inter-generational fairness, which is a theme that has been very popular with this Government.
But this would seem to break the Government’s promise not to increase income tax, NI or VAT, and would upset millions of pensioners.
3. Abolish higher rate pension tax relief
This has been proposed for many years. The Treasury very nearly introduced a completely new system of pension incentives in 2016, but ultimately shied away from the negative headlines that would accompany such a radical change.
It has long been argued that pension tax relief is unfair to average earners and mostly benefits the ‘rich’. The higher earners receive much more generous reliefs than basic rate taxpayers.
Those earning over £50,270 a year can receive much more money from the Government to add to their own pension contributions than someone earning less than them.
With basic rate tax of 20 per cent, the tax relief is equivalent to a 25 per cent bonus added to your pension. For every £4 you put into your pension, the Government adds another £1.
But for a 40 per cent taxpayer, the bonus is 66 per cent added to your contribution. For every £3 you put into your pension, the Exchequer adds another £2.
The deal is even better for 45 per cent taxpayers, but the very highest earners do face reduced annual allowances (see below).
There have been many studies pointing out that an incentive system based on a flat-rate top up to pension contributions, rather than using tax relief, would be much fairer and would ensure the incentives are less inequitable.
A 25 per cent bonus would mean everyone receives the equivalent of basic rate tax relief, so all higher or upper rate taxpayers would lose out.
A 30 per cent bonus added to each person’s pension contribution would redistribute the £70billion of tax and National Insurance reliefs that His Majesty’s Revenue and Customs spends each year, so that lower and middle earners receive more help to build their pension than now, while higher earners receive less.
This sounds attractive in theory, but would also be fiendishly complicated to introduce. It would probably take several years, and would require careful modelling, consultation and analysis, to prepare administration systems for this kind of change.
Depending on how the new incentive ‘bonus’ would work, there could be significant long-term cost savings for the Treasury, while enhancing its efforts to redistribute income from higher to the middle and lower earners.
4. Turn pensions into Isas
This option was seriously considered in 2016 as well. It would save huge amounts of money to the Treasury in the near term, because suddenly the Government would not be spending any money on tax reliefs for new pension contributions.
Isa contributions are made out of taxed income, and then there is no more tax to pay on the investment returns or on withdrawals.
An Isa-Pension could operate on similar principles, but of course without any tax relief on the way in, less money would be going into these types of pensions initially.
The costs to employers would also need to be considered. The Lifetime Isa was an attempt to try out the concept of an Isa-Pension, but it has not proved popular.
Allowing tax-free withdrawals at age 60 would most likely see people cashing in their pension as soon as they can
The Government adds 25 per cent to your own payments into the Lifetime Isa account, which is the equivalent of basic rate tax relief, however the product has serious drawbacks.
This is partly due to the confusion between using the Lifetime Isa for house purchase, or using it as an addition (or replacement) for the annual allowance pension contributions.
Lifetime Isas have arbitrary age limits and money is locked until age 60, rather than 55, and a major problem is the 25 per cent penalty imposed on early withdrawals that are not used for purchasing a qualifying property.
The 25 per cent penalty is more than the 25 per cent bonus added at the beginning, so people have complained about being worse off after putting money into the Lifetime Isa than if they’d invested in an ordinary account.
This radical option would, in my view, undermine pension saving.
Allowing tax-free withdrawals at, say, age 60 would most likely see people cashing in their pension as soon as they can, just in case a future Government changes the rules and imposes new taxes.
5. Change annual allowance rules
The annual allowance is a threshold which restricts the amount of pension savings you are allowed to earn tax relief on each year to £60,000.
The total annual pension contribution cannot be greater than your earnings, so anyone on average earnings could not contribute anywhere near the annual limit.
The Chancellor might want to reduce this to, say, £30,000, saving some money spent on tax relief.
Rachel Reeves may be tempted, more for ideological ‘hit the rich’ reasons than to raise serious revenue, to reduce or even abolish the ‘tapered annual allowance’, which only applies to the very highest earners – those earning over £200,000.
Their permitted annual pension contributions reduce as their so-called ‘adjusted earnings’ increase from £200,000 to £260,000, reaching a reduced maximum of £10,000. It would not save much money as there are relatively few top earners.
Budget 2025: Chancellor Rachel Reeves will announce her plans on 26 November
There is also the ‘money purchase annual allowance’, which the Chancellor may decide to reduce or even scrap altogether.
The MPAA is a £10,000 limit on annual pension contributions that receive tax relief for those who have already taken more than their tax-free cash out of their money purchase defined contribution pension.
Again, this is unlikely to save much money as it only applies to a small proportion of people.
Reducing these annual allowances is straightforward – it is easy to understand and not too complicated to administer. The changes would not really impact the majority of working people, as only the higher earners are likely to find their contributions restricted by these lower limits.
Such changes would also save money in the first year they were introduced, and be maintained in future years, pending a stronger fiscal situation.
The huge drawback to any changes to the allowances relates to defined benefit salary-linked pensions.
The public sector schemes, including NHS, would be seriously impacted as senior staff would find that their high salaries and large pension accruals each year will push them over the lower limit, meaning they will end up paying possibly significant sums in tax on their pension contributions.
The Chancellor could decide to apply the lower annual allowances only to DC pensions and exclude anyone paying into a DB scheme, but that would be deeply unpopular with well-paid workers in the private sector and likely to attract very negative media headlines.
Drawback: Changing pension allowances could impact senior staff in the public sector
6. Limit pension allowance carry forward rules
The current system allows people who have already used their full annual allowance of £60,000 this year to carry forward any unused annual allowance from the last three years as well.
The Chancellor could decide to reduce the number of years that contributions can be carried forward, or even stop carry forward altogether for next year and save some tax relief that way.
Again, this would mostly hit the higher earners, but would not raise significant amounts of revenue.
7. Make auto-enrolment compulsory – and axe tax relief on the minimum contribution levels
The Chancellor could take advantage of current very low opt-out rates for workplace auto-enrolment pensions and follow the Australian example of compulsion.
With participation rates for eligible workers in auto-enrolment being around 90 per cent, changing the rules to make all minimum auto-enrolment contributions compulsory, would affect only a small proportion of the workforce.
The benefits of compulsory contributions would be to ensure all workers were actually building up a private pension fund, to supplement state pensions and also that the Government would no longer need to add an ‘incentive’ to these contributions, because they are compulsory.
Currently, the tax relief on minimum auto-enrolment levels is only a minor element. Employees earning below £50,270 (those on basic rate tax) pay 4 per cent of their ‘band earnings’ into their workplace pension, with the employer adding a further 3 per cent and tax relief at basic rate adds only 1 per cent.
Higher-paid workers receive more than this in tax relief, as explained above.
But all low-paid workers in a ‘net pay’ scheme actually contribute 5 per cent themselves and do not receive any tax relief, so the Government might be tempted to level the playing field under a compulsory system, but ensure all basic rate taxpayers put in 5 per cent (just as the lowest earners in a net pay scheme do) and the employer will add 3 per cent as now.
Because the Chancellor would no longer be paying tax relief to millions of workers, there would be significant cost savings to the Treasury.
Of course, this does mean that there could also be new incentives introduced to encourage people to contribute more than the minimum level, for which they would then receive extra incentives from the Government, but that does not have to happen immediately.
The biggest positive would be significant fiscal savings for the Chancellor. With opt-out rates so low, most workers would be relatively little affected.
But compulsory pension contributions may be very unpopular and could be portrayed as a new type of workplace tax. Increasing the workers’ contributions from 4 per cent to 5 per cent of ‘band earnings’ (between £6,240 and £50,270 a year) would have some social equality merit, but would potentially see workers’ take-home pay reduced.
There could be pressure on employers to pay the extra 1 per cent instead of their employees, adding to cost problems faced by many since recent employer National Insurance increases.
8. Scrap National Insurance relief and salary sacrifice
The cost of National Insurance relief is estimated to be around £20billion a year and is often considered an anomaly of the incentive system.
This is because tax relief was designed to be deferred tax, which allows people to contribute to their pension without being taxed, but then they would pay tax on the pension they receive in retirement.
However, allowing employers to claim National Insurance relief for the pension contributions they pay on behalf of staff is pure tax leakage.
Pensioners do not pay National Insurance on their pension income. In addition employers can use ‘salary sacrifice’ to pass on the savings in National Insurance to workers as well, giving an extra boost to their pension, at no additional cost.
The operation of salary sacrifice is widespread, with the majority of auto-enrolled workers using this system.
Employers have set up costly and complicated administration systems to ensure their auto-enrolment schemes are operating properly.
A decision to ban the use of salary sacrifice and end employer National Insurance reliefs for pension contributions would save billions of pounds a year, but would up-end pension administration systems and add new costs to employers who would have to change all their systems.
It is unlikely this could be introduced quickly – and could take years.
Two pension reforms that would help savers AND the economy
9. Require 25 per cent of all new pension contributions to be invested in British assets
Pension funds should use tax relief to invest in British companies, infrastructure and property assets.
This would help the Chancellor fulfil her economic objectives, at no additional cost to the Treasury.
She needs to boost the economy, revive growth, attract investors to British infrastructure, property and sustainable alternative energy projects, and increase support for British businesses – both new ventures struggling to raise start-up or follow-on finance and established firms that are languishing at low ratings.
At least, say, 25 per cent of all new pension contributions could be invested in British assets – quoted companies, venture capital, start-up capital and real assets such as infrastructure, property and alternative energy.
It could be a game-changer for corporate UK, with billions of pounds newly flowing into British businesses and assets.
Pension funds in all other countries invest with a significant home bias – most other countries have well over 20 per cent or 25 per cent in their domestic assets.
UK pension funds used to have around 50 per cent invested here too, but over the past decade or two, they have consistently been selling UK equities, underinvesting in British businesses, abandoning our markets and putting most of their money overseas.
This has contributed to a major de-rating of corporate valuations, with great British companies – old and new – being unable to find sufficient long-term equity capital.
This has made us all poorer and weakened growth.
It used to be the case that British pension funds were constantly looking for good domestic companies to invest in. But now, these good domestic companies are constantly seeking long-term investors. Losing the reliable flow of pension capital has seen companies struggling to grow, or being snapped up cheaply by overseas competitors.
If pension funds want to put more than, say, 75 per cent of their contributions in overseas assets, instead of here, they would not receive help from British taxpayers.
It would be their choice. This is not mandation, it is a quid pro quo for receiving the taxpayer money.
The Chancellor’s decision to impose inheritance tax retrospectively on unused pensions on death, starting in April 2027, is a disastrous change
10. New tax on unused pensions that bypasses inheritance tax
The Chancellor’s decision to impose inheritance tax retrospectively on unused pensions on death, starting in April 2027, is a disastrous change which has raised too little opposition from the pension industry and commentators.
By including pensions in a person’s estate, the Treasury is going to cause chaos for the loved ones trying to administer and pay tax on the person’s assets.
Currently, there is no difficulty because the pension or other death benefits are mostly outside your estate.
From 2027, the proposal is to force anyone who is responsible for managing the affairs of someone who has died to find out what pensions they had and how much they are worth, to prove that they are the person who is administering the estate, to identify who would inherit the pensions, and to say how much inheritance tax (if any) needs to be paid.
All of this information needs to be verified, calculated and checked carefully for accuracy within six months of the date someone passes away – otherwise not only will inheritance tax be due, but HMRC will charge 8 per cent interest on any inheritance tax not yet paid.
This will put an almost impossible burden on many personal representatives – executors and administrators of estates – who will struggle to provide the right paperwork to pension firms, and will not know all the complexities of the different types of pensions and other benefits that could be paid out.
Instead. to avoid what is obviously going to be an absolute nightmare, the Chancellor could consider introducing a new tax on unused pension benefits, administered completely outside the inheritance tax system, payable by the pension provider.
This could be set at a level of, say, 10 per cent, 15 per cent or 20 per cent, but would apply to all unused pensions, regardless of whether the person’s estate pays inheritance tax.
It would be a straightforward amount to collect and would raise extra revenue for the Chancellor.
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